Why Asset Managers Are Betting On Active ETFs

The idea of an active exchange-traded fund (ETF) has been around for no less than six years now, with the first one being launched back in 2008. [1] It is only over recent months, however, that the investment product has attracted significant interest from investors as a cheaper alternative to actively-managed mutual funds. After all, it combines the flexibility and cost-effectiveness of an ETF with the higher returns that you would normally associate with a fund that has a good manager.

Active ETFs form a negligible part of the country’s mutual fund and ETF industry – less than 0.1% of the $13.9 trillion market at the end of 2013. [2] But the steadily increasing demand for them has prompted the world’s largest asset managers to explore the offering seriously. While BlackRock filed for the launch of 13 such funds through BATS Global Markets in May, State Street (NYSE:STT) is adding to its existing portfolio of active ETFs with its first actively-managed bond ETF in a tie-up with DoubleLine Capital. [3] Among large banks, UBS (NYSE:UBS) already has an active ETF in its lineup, whereas Wells Fargo (NYSE:WFC) recently detailed plans to offer one in an SEC filing. [4] All this activity clearly shows that asset managers expect strong inflows into active ETFs over the coming months, and they are making sure that they get a piece of the action.

ETFs have been the fastest growing investment vehicle for institutional as well as retail investors in recent years – turning from an obscure product at the turn of the century to an almost $2.3 trillion global industry now. ETFs in the U.S. had $1.6 trillion in assets at the end of 2013 – almost 12% of the $13.9 trillion in total assets managed by all mutual funds and ETFs in the country. [2] In comparison, the relatively new active-managed ETFs have a little more than $13 billion in assets combined. [3]

Active ETFs are, however, seen as the “next big thing” in the industry, as they can potentially grant retail investors easy and cost-effective access to the services of professional fund managers – something that only institutional and high-net-worth clients currently have access to. To add to that, active ETFs have the additional benefits of transparency, flexibility as well as liquidity compared to actively-managed mutual funds. [1] All these factors taken together make active ETFs a strong bet for asset managers.

As of now, PIMCO holds a 61% share of the active ETF market – with its eight funds managing $7.9 billion in assets. [3] The bigger players are now eyeing a larger share with a series of offerings targeting the nascent market. These asset managers have also been lobbying the SEC for a new set of ETFs which address concerns active fund managers have with the transparent nature of actively-managed ETFs. [5] As trading strategies can be replicated easily by others if the underlying holdings are detailed at the end of each day (a mandatory requirement for all ETFs), well performing active ETFs won’t have a competitive advantage. In fact, they potentially stand to lose, as their large positions will be more difficult to change if smaller funds follow the same strategy.

While a solution to this concern can only mean good news to the future of active ETFs, what remains to be seen is whether they actually live up to the hype generated around them over recent months. If they do witness exponential growth in the near future, then this will help boost the already strong growth in ETFs for global asset management giants. You can understand how changes in the size of assets managed by State Street’s ETFs affects its share price by making changes to the chart below.

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